A Preliminary Evaluation of Monetary Policy Rules for Russia

Transcription

1 A Preliminary Evaluaion of Moneary Policy Rules for Russia November 2003 Preliminary Draf. Please do no quoe Akram Esanov Chrisian Merkl Lúcio Vinhas de Souza 1 Absrac The paper reviews he recen conduc of moneary policy and he cenral bank s rulebased behaviour in Russia. Using several policy rules, we es wheher cenral banks in Russia reac o changes in inflaion, oupu gap and he exchange rae in a consisen and predicable manner. Our resuls indicae ha during he period of he Bank of Russia has used moneary aggregaes as a main policy insrumen in conducing moneary policy Key words: moneary policy rules; exchange rae; cenral bank; Russia JEL Classificaion: E52, F33, F41, E61 1 Kiel Insiue for World Economics (IfW). Chrisian Merkl is a suden a he IfW s ASP (Advanced Sudies Program), Akram Esanov is boh a Research Assisan a he IfW and a ASP suden, and Lúcio Vinhas de Souza is an Economis a he IfW. Akram Esanov and Lúcio Vinhas de Souza were financed by he USAID/IRIS Projec n 220/ Corresponding auhor: Lúcio Vinhas de Souza, Kiel Insiue for World Economics (IfW), Düsernbrooker Weg 120, Kiel, Germany, phone +(49)(431) , fax +(49)(431) , desouza@ifw.uni-kiel.de. Websies: hp:// and hp:// 1

2 1. Inroducion The effecive developmen of a financial secor implies he need for insiuions, policy-seing, regulaory and supervisory ones. Arguably, he mos imporan of such insiuions is he moneary auhoriy, he cenral bank. Therefore, he developmen of he Russian financial sysem, and is imporance for long-erm growh and sabiliy, canno be seen separaely from he developmen and effeciveness of is moneary auhoriy, from is capaciy in seing and pursuing a moneary policy. Consequenly, our aim in his wok is o sudy he differen ools and rules, and heir effeciveness, ha he Cenral Bank of Russia has a is disposal. The las en years have winessed an upsurge in research on moneary policy rules evaluaion moivaed by he seminal paper of Taylor (1993). An evidence of his is he enormous volume of recen papers and conferences on he opic. Taylor s original paper shows ha he ineres rae seing behavior of he Federal Reserve Sysem in he US can be characerized by a simple reacion funcion where shor-run nominal ineres rae used as an insrumen by he Fed changes in response o deviaions in inflaion and oupu gap. Following his sudy, a grea number of researchers have invesigaed he Fed s behavior using a simple Taylor rule or wih some variaions, like including lags of shorerm ineres rae or oupu deviaion. Overall, in case of he US or oher developed counries, he Taylor like rule explained very well cenral banks behavior indicaing ha in developed counries mos of he ime cenral banks reaced in a way o sabilize deviaions eiher from a arge level inflaion or oupu gap. 2

3 However, in case of developing counries and emerging markes, le alone daascarce ransiional economies, findings of moneary policy rule evaluaions were inconsisen and resuls ofen changed from sudy o sudy depending upon ime span and model specificaion. These conflicing findings are explained by several facs, such as ha in developing and emerging counries, financial markes are no maure, some of hese economies adop fixed exchange rae regimes and ha he objecives of he moneary auhoriy in hose economies differ from ha of he indusrial counries. Despie hese discouraging observaions, over he pas few years a number of sudies has invesigaed moneary policy rules in emerging markes, finding ha even wih all shorcomings, cenral banks in emerging markes follow a rule-like policy in conducing moneary policy and, wih appropriae modificaions, a simple Taylor rule can describe well he shor-erm behavior of ineres raes. Because of model specificaion difficulies and problems associaed wih collecing reliable daa, very lile research has been done on moneary policy rule in ransiional economies. This is one of he firs aemps o fill his exising gap. This paper examines he conduc of moneary policy in Russia during he period of The Russian economy has experienced sharp swings since he collapse of he Sovie Union in The sar of ransiion from planned economy o a marke economy riggered a severe drop in oupu and he economy did no fully recover unil However, early signs of recovery were dashed by he Augus 1998 defaul and following financial crises. Since 1999 he Russian economy has been experiencing a robus growh due o high oil prices and rade surplus, generaing a real exchange rae appreciaion. 3

4 Agains his background we would like o invesigae Russian cenral bank s behavior over he pas en years. Paricular aenion will be given o he evaluaion of moneary policy rules for Russia. The res of he paper is organized as follows. Secion 2 briefly reviews he recen lieraure on moneary policy rule. Secion 3 describes evoluion of moneary policy insrumens and regime changes in he Russian cenral bank in a chronological order. Secion 4 specifies differen empirical models o be used in evaluaing moneary policy rule while secion 5 presens resuls of empirical esimaion. Finally, secion 6 draws some conclusions. 2. Review of he Lieraure Since he famous paper by Taylor (1993), much of he research on moneary policy rule has focused on developed counries. The widely used simple insrumen rule is called a Taylor rule, where ineres rae responds only o he inflaion and oupu gaps according o i = β + β ( π π ) + β ( y y ), (1) * * where i is he insrumen rae in period, β0 is a consan, * π π is he inflaion gap, where π is he rae of inflaion and * π 0 is a given inflaion arge, y y is he * oupu gap, where y is log of oupu and β1 and β2 are posiive 2. * y is log of poenial oupu, and he coefficiens 2 More specifically, he condiion ha deermines a unique non-explosive equilibrium, corresponding o he opimal commimen, is β 1 >1 and 0< β 2 <1 (see Woodford, 1999). 4

5 Since hen, subsanial research in his area has aemped o examine his simple insrumen rule and conribued many imporan insighs. Paricularly, researchers show ineres in evaluaing he conduc of moneary policy in developed counries using a simple Taylor rule. The general finding of his lieraure is ha varians of he Taylor rule perform quie well in explaining cenral bank behavior in indusrial counries and esimaions are robus, in he sense ha resuls do no subsanially change across differen model seings. Furhermore, here is a widely acceped agreemen among researchers ha no cenral bank adops a simple rule as a formal policy rule in conducing moneary policy alhough differen modificaions of he Taylor rule have been used as a guideline in a decision-making process. Applicaion of a rule-like policy in emerging markes and ransiional economies raises he quesion as o usefulness of rule-based moneary policy, and in a greaer exen, abou he effeciveness of moneary policy, given he specific marke srucure of emerging economies. Again Taylor (2000) addresses his quesion and argues ha policy rules have many of he same advanages in emerging markes ha hey have in developed economies. As o he choice of policy insrumen in conducing moneary policy in emerging economies, he saes ha given he specific naure of markes in emerging economies, he policy insrumen could be no only shor-erm ineres rae bu also he moneary base or some oher moneary aggregae. Furhermore, he sresses he imporance of exchange raes in moneary policy rule seing in emerging economies and argues ha inclusion of exchange rae in he cenral bank reacion funcion does no conradic o he objecive of cenral bank since in emerging economies someimes 5

6 exchange rae sabilizaion is a precondiion for oupu sabilizaion and in bringing down inflaion o a argeed level. Regarding usefulness of moneary policy in emerging economies Taylor (2001) argues ha even hough effec of moneary policy on real variables hrough he financial markes is limied because of he less developed naure of hese markes, sill moneary policy could have significan impacs hrough changes in wages and propery prices. So, a predicable behavior of cenral banks in emerging economies considerably improves he ransmission and effeciveness of moneary policy. In line wih his heoreical argumen over he pas few years he moneary policy regime in emerging economies has shifed owards adoping a rule like policy. For insance, Mohany and Klau (2003) indicae ha ou of 13 leading emerging economies in heir sudy, only wo had no adoped inflaion argeing (IT), a relaed ype of rule-based policy 3. Given he fac ha inflaion argeing leads o a more sysemaic response by he cenral bank o inflaion, he ineres rae seing process in hese economies has been guided by a rule-like policy. The main conclusion of heir sudy is ha in emerging economies cenral banks, mos of he ime, change shor-erm ineres rae in response o deviaions in inflaion and exchange rae movemens. They also noe ha, alhough price sabilizaion remains a main objecive of cenral banks in emerging counries, oher objecives such as oupu sabilizaion, sabiliy of he exchange rae and in few cases, sabiliy of asse prices and curren accoun defici, can be highlighed as a cenral bank s objecive. 3 The counries in heir sudy are: Brazil, Chile, Czech Republic, Hungary, India, Korea, Mexico, Peru, he Philippines, Poland, Souh Africa, Taiwan and Thailand. Of his se, only India and Taiwan had no inroduced a inflaion argeing regime by lae

7 3. Developmen of Moneary Policy Insrumens in Russia The dissoluion of he USSR a he end of 1991 did no immediaely lead o he esablishmen of a ruly Russian moneary auhoriy (he Bank of Russia), capable of conducing an independen and effecive moneary policy 4, as, unil mid 1993, some of he former republics of he Sovie Union sill used he ruble, he Russian naional currency, and cenral banks of hose republics conduced heir own credi policy simulaneously wih he Bank of Russia. Only afer 1993 he Bank of Russia sared o conduc is own independen moneary policy, alhough he scope of he policy was limied by he need o finance a huge budge defici, mainly caused by a dramaic decline in oupu (see Figure 3). This loose moneary sance coninued unil he mid of 1995, when he Russian economy sared showing signs of sabilizaion and a new law on he Bank of Russia was passed, providing some degree of legal independence o he Bank of Russia in conducing moneary policy 5. These posiive developmens have allowed he Bank of Russia o adop a igher moneary policy and o inroduce a pegged exchange rae regime wih a crawling band agains he US dollar from July 1995 onwards. As a resul of hese measures inflaion slowed down (see Figure 2). Furhermore, because of favorable developmens in local securiies marke, direc credi o he governmen significanly decreased and he Bank of 4 The Cenral Bank of he Russian Federaion (Bank of Russia) was founded on 13 July 1990, based on he Russian Republic Bank of he Sae Bank of he USSR. On 2 December 1990, he Supreme Sovie of he RSFSR passed he Law On he Cenral Bank of he RSFSR (Bank of Russia), which declared he Bank of Russia a legal eniy and he main bank of he Russian Federaion 5 Neverheless, sill oday he Bank of Russia mainains some funcions no radiionally seen as belonging o a cenral bank: for insance, in spie of being a baking supervisor and regulaor, he CBR has a majoriy sake in he larges Russian bank (and sae owned bank), Sberbank Rossii, who has 23% of all banking asses, 70% of household deposis, 20% of corporae deposis and 21,000 branches across Russia, and, unil lae 2002, also had paricipaion in he second he second larges sae owned bank, he VTB. Also, acing as an agen for he Minisry of Finance, i se up and manages he governmen securiies marke, known as he GKO marke. 7

8 Russia sared o conduc moneary policy hrough indirec insrumens, such as ineres raes and reserve requiremens. However, he sar of Asian crisis of 1997 spread a negaive shock hroughou emerging markes. This unfavorable exernal shock decreased invesmen confidence in Russia and caused capial ouflows, forcing he Bank of Russia o defend he band. Alhough during he exchange marke inervenions in November 1997 he Bank of Russia los over $6 billion of is liquid reserves, which was equal wo hirds of oal reserves a ha ime, he exchange band was successfully defended for a while. Despie hese effors of he Bank of Russia, due o he severe Augus 1998 financial crisis, he governmen was forced o defaul is domesic deb obligaions. The ruble was devaluaed and he exchange rae band was abandoned leading o adopion of a floaing regime. One consequence of he sharp depreciaion was a rapid acceleraion in inflaion. Alhough ruble-denominaed deb was resrucured, invesor confidence kep declining because of an increase in poliical uncerainy and privae capial ouflows. Under such a siuaion, he Bank of Russia, fulfilling is role as a lender of las resor, aemped o preserve he paymen sysem, which came o a hal during his period, by injecing liquidiy ino banking sysem hrough a reducion of reserve requiremens and exending large amoun of new credis. However, base money declined significanly in real erms reflecing he sharp decline in oupu and increased use of non-moneary forms of paymen. 8

9 Figure 1. Real and Nominal Effecive Exchange Raes (1995=100) REER NEER Figure 2. Refinancing Rae and CPI (Quarerly Based, in percen) REFINANCINGQUARTERLYBAS QUARTERLYCPI 9

10 Figure 3. GDP Index and M1 Index (1993=1) GDPINDEX M1INDEX From 1999 onwards, one of he main objecives of he Bank of Russia was o bring inflaion down o 30 %, while keeping oupu decline in he range of 1-3 percen, wihin he framework of a diry floa of he Ruble. To achieve his objecive, moneary policy was ighened by reducing ne credi o banking sysem. Because of his measure, inflaion fell sharply and he exchange rae depreciaion slowed. Furhermore, fiscal performance significanly improved due o he approval of a new package of fiscal measures and improvemens in revenue collecion. The exernal environmen srenghened as world energy prices increased, generaing rade surplus and capial inflows, causing he exchange rae o become one of he main arges of moneary policy (see Figure 1). According o he Bank of Russia he main objecive of he moneary policy in 2000 was o reduce inflaion o 18 % and o achieve an annual growh rae of GDP 1.5 percen. However, he coninuing srengh of he balance of paymens and he Bank of Russia s 10

11 relucance o permi a real appreciaion of he ruble has placed increasing pressure on moneary policy. Given his coninued favorable economic siuaion in recen years, he Bank of Russia has placed more weigh on he exchange rae sabiliy, while acceping he inflaionary consequences of such a decision. This policy of he Bank of Russia has slowed he real appreciaion of he ruble and reduced inflaion, even hough he pace of disinflaion has been slower han he one formally argeed by he auhoriies Specificaion of he Empirical Model The recen lieraure on moneary policy rule primarily disinguishes wo ypes of insrumen rules: ineres rae based insrumen rule and moneary based insrumen rule, referred o as he Taylor rule and he McCallum (see McCallum, 1988) rule, respecively 7. The key difference in hese rules involves he choice of an insrumen in cenral bank s reacion funcion in response o changes in macroeconomic condiions. The Taylor rule, as specified in secion 2, uses a shor-erm nominal ineres rae as an insrumen and is widely used in moneary policy esimaions because of is simpliciy and realisic naure. The McCallum rule uses he growh rae of moneary base as an insrumen and can be expressed as follows: where * * b = x v +.5( x x ), (2) 0 1 b is rae of growh of he moneary base, percen per year, of growh of nominal GDP, percen per year, * x is he arge rae v rae of growh of base velociy, percen 6 The policy relevance of such concerns wih real appreciaion are somewha doubful, as is unclear ha he Russian Ruble in above is long run equilibrium value, or merely recovering from an undershooing (see IMF, 2003). 7 Razzak (2001) shows ha he McCallum and Taylor rules are co-inegraed. 11

12 per year, averaged over he previous four years, in he original McCallum esimaion,, and x is rae of growh of nominal GDP, percen per year. In his rule he arge value of nominal GDP growh is calculaed as he sum of he arge inflaion rae and he long-run average rae of growh of real GDP. Originally he boh rules were designed o be used in evaluaion of he moneary policy in large indusrial counries, and many observers expressed concerns regarding he effeciveness of his basic policy rules for evaluaing he conduc of moneary policy in emerging economies. This concern raises he quesion as o wha kind of modificaion are needed o fi beer he realiies of emerging economies wih underdeveloped financial markes, dependence on primary commodiy expors, sharp swings in produciviy and relaive prices, and high exposure o volaile capial flows. To address adequaely his quesion researchers use modified versions of hese insrumen rules. One general consensus in his regard is ha moneary policymakers in emerging economies are more concerned abou exchange rae movemens han hose in maure economies, among oher reasons due o he degree of exchange rae pass-hrough o prices, and his feaure has been incorporaed ino cenral bank s reacion funcion 8. Some researchers, such as Ball (1998) even sugges ha, in an open economy, he cenral bank could use weighed average of nominal ineres rae and exchange rae as an insrumen. However, his approach has no been popular among empirical researchers because of uncerainies involved in deermining weighs. Since 1991 he Russian economy has experienced boh sharp flucuaions in main macroeconomic variables and deep srucural changes. Given his unsable naure of 8 Deken and Gaspar (2003), show ha a moneary auhoriy ha cares abou price deviaions will also care abou exchange rae developmens, even wihou formally argeing hose. 12

13 economic environmen in Russia, he ask of esimaing a moneary policy rule is complicaed and one may a priori assume ha no single policy rule would fully capure all aspecs of cenral bank behavior during his period. However, close observaion of moneary policy decision-making behavior of he Bank of Russia indicaes ha i is worh o analyze moneary policy in Russia in he conex of a rule based reacion funcion. We sar our analysis wih he esimaion of a modified version of he famous Taylor rule. In his seminal work, Taylor (1993) proposed he following, now well-known, policy rule o describe he Fed s behavior in seing he shor erm ineres raes: i = π + 0.5y + 0.5( π 2) + 2, (3) where i is he shor erm ineres rae, p is he inflaion over he four previous quarers, y is he percen deviaion of real GDP from a arge. The inflaion arge and he equilibrium real ineres rae are se a 2 and assumed as consan over ime. The policy maker is here assumed o care equally abou deviaions of inflaion and oupu from arge. In his formulaion Taylor used a linear rend o approximae poenial oupu. This simple equaion canno be esimaed in he original form in he case of Russia, since a relaively sable long-run average inflaion does no exis. The only way o esimae equaion 3 is o assume ha here is a consan inercep and esimae he coefficiens by running a simple regression wihou specifying he oher parameers of he model. Our iniial resuls, where he oupu gap was calculaed by using a linear derending approach generaed unsaisfacory resuls, so we recalculaed he oupu gap making use of a differen approach, namely he radiional Hodrick-Presco (HP) filer 9. 9 The HP filer is he usual mehod o smooh-ou he esimae of he long-erm rend componen of a series. I is a wo-sided linear filer ha compues a smoohed series, denoed by os, of a original series, 13

14 In a laer work, Taylor (2001) suggesed ha marke condiions in emerging economies may require modificaions of he original policy rule, which had been designed o describe moneary policy behavior in developed counries. In his regard, one possible modificaion of he original Taylor rule could be inclusion of one measure of he exchange rae ino he equaion, since for many emerging economies exchange rae flucuaions are of a grea concern, because, as indicaed above, of heir vulnerabiliy o eiher exernal shocks, high exchange rae pass-hrough, generaing he fear of floaing phenomenon (Calvo and Reinhard 2000). Given hese consideraions, we esimae he following modified open economy Taylor rule: i = β + βπ+ β y + β xr + β xr + βi + u, (4) where xr is he growh of he real effecive exchange rae, u is a whie noise error erm and -1 indicaes he pas values of he variables. The remaining variables are he same as in he equaion 3. The expeced signs of he parameers are as follows: β 0, β 2, β 5 are posiive (bu β 5 #1), β2 /(1 β5) > 1, β 3 < 0, and β 4 is undefined (and β 1,>1). Money based rules As discussed in secion 2, he refinancing rae (shor-erm ineres rae) has no been he mos imporan insrumen in conducing moneary policy in Russia due o several facors such as underdeveloped naure of capial markes and limied role of he banking denoed by y hp below, by minimizing he variance of y around os, subjec o a penaly parameer ha consrains he second difference of os. Tha is, he HP filer chooses os as o minimize T = 1 2 T 1 ( y os ) + ( ) ( ) hp, λ = 2 2 [ ] os The penaly parameer λ conrols he smoohness of he series. The larger he λ used, he smooher he series os will be. The HP filer has known limiaions on shor samples and also on is esimaed end sample. + 1 os os os 1 14

15 secor in supply of funds. Thus, he Bank of Russia has been placing an equal imporance on oher insrumens such as non-marke based inervenions (specially a he beginning of he ransiion period), exchange rae inervenions or he change of minimum reserve requiremens in conducing moneary policy. Furhermore, before he 1990s, moneary aggregaes have ofen been referred in policy analysis as an imporan moneary policy insrumen 10, as he uncerainy in measuring real ineres raes and big shocks o invesmen or ne expors would make moneary aggregaes a preferred insrumen. This may sill be he case in Russia, and especially a he beginning of he nineies (See Taylor, 2000). Despie he problems associaed wih he direc conrol of he M1 moneary aggregae and significan flucuaions in moneary velociy, we use his aggregae as a policy insrumen in conducing moneary policy in Russia. We are also aware of he fac ha some exising sudies aemp o explain inflaion dynamics by he growh of moneary aggregaes (see e.g. Korhonen and Pesonnen, 1998, Dabrowski e al. 2003) using hose as an explanaory variable. However, our Granger causaliy ess indicae ha a leas in he shor-run here (up o seven monhs) is only a Granger causaliy from prices o M1 and no he oher way around. I is widely acceped ha he ime series daa usually suffer from some level of auocorrelaion, and if his is no correced he esimaion resuls canno be reaed as reliable. To correc for he auocorrelaion problems, we will use differences raher han levels and add several lags, according o informaion crieria and saisical significances of he coefficiens. 10 Perhaps he mos radiional of hose moneary argeers was he German Cenral Bank, he Deusche Bundesbank. Neverheless, several works (see, for insance, Clarida and Gerer, 1996) pu ino quesion he exclusive or even main- reliance of he Bundesbank on moneary aggregaes even during is golden age. 15

16 A Hybrid Rule Ball (1998) argues ha ineres rae based Taylor rules are inefficien unless hey are modified. He sresses ha moneary policy affecs he economy hrough exchange rae as well as ineres rae channels. Ball ses up a simple model wih an open economy IS curve, Phillips curve and a link beween ineres and exchange rae. Rearranging erms yields he following opimal policy rule: wi + (1 w) xr = α y + βπ ( + δxr 1), (5) where w is a weigh ha depends on he calibraion of he model and δ is he effec of a one percen exchange rae appreciaion on inflaion, α and β also depend on calibraions of he model. The calibraion parameers we use will be based on he work of Ball (1998). We use differen weighs and check heir effec on he esimaed coefficiens. Finally, o address he economeric problem caused by several possible srucural breaks in he Russian economy during he period , we use differen combinaions of dummy variables. 16

17 5. Empirical resuls Daa and Mehodology Daa for Russia have o be cauiously reaed. The availabiliy is limied and phenomena such as dollarizaion and he barer economy may lead o a somewha biased picure. Some auhors (see e.g. Falcei e al. (2000)) also believe ha he decline in oupu was overesimaed during he firs years of he ransiion period 11. In our empirical esimaions we use monhly daa covering he ime span The period has been chosen for daa availabiliy reasons. Alernaively, in several occasions we use quarerly daa o check he robusness of our resuls. The sources of he daa are he Inernaional Moneary Fund s Inernaional Financial Saisics daabase, he web sie of he Bank of Russia, he monhly daabase of he Vienna Insiue for Inernaional Economic Sudies (WIIW), and he Russian European Cenre for Economic Policy (RECEP). For our purpose we need he daa on he shor-erm ineres rae (refinancing rae), he consumer price inflaion, he moneary aggregae M1, he oupu gap, differen exchange rae measures (dollar exchange rae, nominal effecive exchange rae, and real effecive exchange rae), he labor share (for an alernaive proxy of he oupu gap), and he budge defici. We use oupu numbers from RECEP and WIIW (indusrial producion numbers) and deflaed hem by monhly CPI because of he lack of a monhly GDP deflaor. 11 For insance, Åslund (2001), esimaes ha, for an official figure of jus 60.2% of he Russian 1989 GDP in 1995, he acual figure, afer aking ino accoun, among oher hings, illegal and under-repored aciviies, was an amazing 94%, or, in oher erms, a mere marginal GDP loss. 17

18 Resuls for he Taylor Rule The esimaion resuls of he Taylor rule sugges ha he Bank of Russia reacs o each poin increase of yearly inflaion rae wih a mere 0.3 poin increase of he refinancing rae. The esimaed coefficien is significan a he 1 percen significance level. However, he esimaed coefficien of he oupu gap shows a wrong sign (negaive) and is no significan (for resuls see Table 1 in he Annex). When we use monhly or quarerly daa insead of annual inflaion, he esimaed coefficien rises more han proporionally, which may indicae a very srong reacion o shor-erm inflaion pressures. The daa fis beer he model when we use year-o-year inflaion numbers. The Granger causaliy ess indicae ha CPI Granger-causes he refinancing rae if we have less han six lags. Wih more han six lags he causaliy relaionship goes ino he oher direcion. When we deflae he refinancing rae by he monhly CPI daa and add dummies for he hree monhs before he financial crisis in 1998 (May, June, July) and one monh aferwards, we obain he heoreically expeced resuls (see able 2 in he Annex). Almos all of he esimaed coefficiens show he expeced signs and are significan a a 1 percen significance level. The only excepion is he inercep erm. However, hese highly significan resuls suffer from a srong firs-order and higher-order-auocorrelaion problem. When we esimae he open economy version of he Taylor rule, he esimaed coefficien of inflaion shows he expeced sign across he differen equaion specificaions. The esimaed coefficien of he oupu gap shows neiher he righ sign, nor is significan (for resuls see Table 2 in he Annex). Oher proxies of he oupu gap, 18

19 such as he real uni labor cos suggesed by Gali and Gerler (1999), also show unsaisfacory resuls. The esimaed coefficiens of he real effecive exchange rae and he nominal effecive exchange rae are only significan under cerain model specificaions and mos of he imes have he wrong sign. However, when we use he nominal dollar-ruble exchange rae, he esimaed coefficien shows he righ sign. The esimaed coefficien of he lagged ineres rae is equal o 0.9 (very close, herefore, o he value necessary for a non-explosive equilibrium), and his value remains sable over he differen model specificaions, indicaing ha he ineres rae in a new period is abou 90% of he old ineres rae, plus he effec of he oher independen variables. Overall, he esimaion resuls sugges ha a simple Taylor rule and is modificaions do no describe well he ineres rae seing behavior of he Bank of Russia. The resuls are no robus, in he sense ha hey depend on he model specificaion and suffer from some saisical problems such as auocorrelaion. Resuls of Money Based Models Because of daa availabiliy problem for he M1 series, some missing poins have been recovered by using he M2 series, since hose wo series are highly correlaed. We deflaed he approximaed M1 series wih he monhly consumer price index. We expec ha signs of he esimaed coefficiens will be reversed because a decrease in he M1 means moneary conracion and a decrease in he ineres rae a moneary expansion. As he regression resuls indicae, in general he simple money based policy rule or McCallum rule, performs much beer in explaining he behavior of he Bank of Russia compared wih a simple ineres rae based rule or he simple Taylor rule (see Tables 1 19

20 and 2 in he Annex). The esimaed coefficiens show he righ signs, bu boh he oupu gap and budge defici measures are insignifican, even hough hese resuls no longer suffer from a firs-order auocorrelaion problem. When we replace he refinancing rae in our previous open economy rule by he moneary aggregae M1, he resuls shows he expeced signs, and he coefficiens are significan. However, he M1 series is non-saionary and his cass some doub o he robusness of he resuls. When we correc his problem by differencing, he resuls mosly remain unchanged, excep for he oupu gap (and also when replacing i by nominal or real GDP). These resuls allow us o conclude ha he Bank of Russia has been argeing moneary aggregaes in is policy decisions. A imes of high inflaion pressure, he Bank of Russia responded by limiing he M1 growh, while a imes of exchange rae appreciaion he policy response was an expansionary moneary policy. Moreover, hese resuls are no sensiive o he model specificaion and here are no major saisical problems. Given he absence of explici inflaion argeing in Russia we esimae in equaion 6 a gap model as defined in Mohany and Klau (2003). The advanage of his model is ha i allows us o use an HP measure of rend inflaion insead of a argeed level, and I given by D(log( M1)) = β + β ( CPI CPIrend) + β y + β d(log( M ) + u 2 + β ( xr xrrend) + β ( xr xrrend where CPIrend is he Hodrick-Presco (HP) filer of he inflaion rae, xrrend is a log of he HP-filer of he exchange rae change. We add anoher lag of CPI o conrol for auocorrelaion problems. In addiion, we include seasonal dummies for December and January and a dummy for he period before (6) 1 ) + 20

21 The regression resuls indicae ha he Bank of Russia reaced o above rend inflaion wih a conracion in M1. If he dollar exchange rae in he curren period is higher han he HP-rend, he Bank of Russia also responded wih a reducion in M1. All esimaed coefficiens are significan and exhibi he righ signs. However, if we subsiue monhly inflaion daa wih quarerly inflaion daa, he resuls are no longer significan, indicaing ha he Bank of Russia is more concerned wih shor-erm inflaion pressures. Esimaion Resuls for he Ball Rule The esimaion resuls for he open economy Ball model are mixed and unsable (see Table 3, Annex). Tesing responses during differen ime periods The Russian economy has experienced differen shocks during differen ime periods. I would be ineresing o see wheher he Bank of Russia has responded differenly during differen ime periods. Since he money based model performs beer, we will es for differen policies during differen ime periods in his model 12. Firs of all, we separae he period before and afer 1995, as Chow breakpoin ess indicae a srucural break a his ime. We use for his purpose he equaion of he following ype: (log( M1)) = β + β *inf + β * dummy*inf + β * y + β * dollarexchangerae + β * dummy* dollarexchangerae + β * dollarexchangerae 4 β d(log( M ) + β * dummydec+ β * dummyjan+ β * dummydec+ u (7) Esimaing he ineres rae rule wih a similarly varying imeframe do no subsanially change he previous resuls. 21

22 where dummy is a dummy variable ha is 1 for he period before 1995 and zero oherwise. The esimaion resuls clearly sugges ha he Bank of Russia conduced a differen moneary policy before and afer The esimaed coefficiens indicae ha before 1995 he Bank of Russia was more concerned wih reducing inflaion 13, while afer 1995 prioriies have shifed owards exchange rae sabilizaion. These findings are consisen wih he official announcemens of he Bank of Russia. The resuls also remain unchanged when we used he quarerly daa, insead of monhly. We obain a similar resul when we use a dummy variable for he crawling peg period, from Ocober 1994 hrough Augus As one would expec, he commimen o reac o exchange rae changes was greaer during ha period. During he high inflaion period, he Bank of Russia aached a greaer prioriy o inflaion, while a imes of relaively low inflaion he main concern was exchange rae sabilizaion. 13 Of course, average inflaion pre-1995 was also subsanially greaer han pos

23 6. Concluding Remarks This paper examined he conduc of moneary policy in Russia during he period of We esimaed hree ses of moneary policy rules, he Taylor rule, he McCallum rule and he Ball rule, using he monhly and quarerly daa. The regression resuls indicae ha a simple Taylor rule and is differen variaions, where he shor-erm ineres rae is used a policy insrumen, describe poorly he ineres rae seing behavior of he Bank of Russia. The resuls are unsable, changing wih he model specificaion and he ime span covered. In addiion, he regular saisical ess indicae he exisence of some economeric problems, furher complicaing he inerpreaion of he resuls. The McCallum rule, where he policy insrumen is a moneary aggregae, fis beer he daa 14. This is in sharp conras wih he recen experience of oher advanced emerging markes, were ineres rae rules produce a very good descripion of he policy seing behavior of he moneary auhoriy (see, for insance, Mohany and Klau (2003), Torreas Garcia (2003), Minella a al. (2003)). The esimaed coefficiens are significan and remain unchanged across differen equaion specificaions. The resuls indicae ha during he period of , he Bank of Russia has used moneary aggregaes as he main policy insrumen in conducing moneary policy. Furhermore, he resuls presened here also sugges ha before 1995, he Bank of Russia was more concerned wih inflaion reducion, while afer 1995 he primary objecive was exchange rae sabilizaion. The esimaion resuls of he hybrid rule or Ball rule, where weighed average of he ineres 14 One mus remember ha, even oday, he CBR main acual insrumen of moneary policy are deposi aucions. 23

24 rae and he exchange rae is used as a policy insrumen, draw a mixed picure. Depending on he choice of he weighs, resuls change and mos of he ime he esimaed coefficiens are insignifican. The resuls on our esimaions, of course, are backward looking, in he sense ha he represen he relaionships ha exised so far in he daa. As he experience of oher advanced emerging markes show, he promoion of forward looking behavior among Russian economic agens, aided by he developmen of sronger insiuions -especially by he srenghening of he credibiliy of he Bank of Russia, plus he deepening of Russia's financial markes, shall, in ime, enable he implemenaion of a successful ineres-rae policy rule, coupled wih inflaion argeing and a floaing exchange rae regime. 24

25 References: Åslund, Anders. The Myh of Oupu Collapse afer Communism. Carnegie Endowmen Working Papers Series, n 18, March Ball, Laurence (1998), Policy Rules for Open Economies, NBER Working Paper No Calvo, Guilermo and Reinhar, Carmen (2000), Fear of floaing, NBER Working Paper No Clarida, Richard and Gerler, Mark (1996). How he Bundesbank Conducs Moneary Policy. NBER Working Papers No, Dabrowski, Marek, Paczynski, Wojciech, and Rawdanowicz, Lukasz (2002), Inflaion and Moneary Policy in Russia: Transiion Experience and Fuure Recommendaions, CASE Sudies and Analyses. Deken,Carsen and Gaspar, Víor (2003). Mainaining price sabiliy under freefloaing: a fearless way ou of he corner?, ECB Working Papers series No Falcei, Elisabea, Raiser, Marin, and Sanfey, Peer (2000), Defying he odds: iniial condiions, reforms and growh in he firs decade of ransiion, EBRD Working Paper No. 55. Gali, Jordi, and Gerler, Mark (1999), Inflaion Dynamics: A Srucural Economeric Analysis, Journal of Moneary Economicvs, 44(2), Ocober 1999, IMF (2003). Russian Federaion: Seleced Issues. Counry Repor No. 03/146. McCallum, Benne (1988), Robusness properies of a rule for moneary policy, Carnegie-Rocheser Conference Series on Public Sociey 29 (1988), , Norh- Holland. 25

26 Minella, André, Springer de Freias, Paulo, Goldfajn, Ilan Kfoury Muinhos, Marcelo (2003). Inflaion Targeing in Brazil: Consrucing Credibiliy under Exchange Rae Volailiy. Working Paper presened a he Kiel Workshop for Moneary Policy and Macroeconomic Sabilizaion in Lain America, Kiel Insiue for World Economics, Sepember Mohany, Madhusudan, and Klau, Marc (2003), Moneary policy rules in emerging marke economies, Issues and Evidence. Working Paper presened a he Kiel Workshop for Moneary Policy and Macroeconomic Sabilizaion in Lain America, Kiel Insiue for World Economics, Sepember Pesonen, Hanna, and Iikka, Korhonen (1998), The Shor and Variable Lags of Russian Moneary Policy, Review of Economies in Transiion, 1998, No.4, Bank of Finland. Razzak, W. (2001).Is he Taylor rule really differen from he McCallum rule? Reserve Bank of New Zealand Discussion Paper 2001/07 Taylor, John (1993), Discreion versus policy rules in pracice, Carnegie-Rocheser Conference on Public Policy 39, , Norh Holland. Taylor, John (2000), Using Moneary Policy Rules in Emerging Marke Economies, Revised paper presened a he 75 h anniversary conference a he Banco de Mexico. Taylor, John (2001), The role of he exchange rae in moneary-policy rules, American Economic Review Papers and Proceedings 91, Torres Garcia, Albero (2003). Moneary policy and ineres raes: evidence from Mexico. Working Paper presened a he Kiel Workshop for Moneary Policy and Macroeconomic Sabilizaion in Lain America, Kiel Insiue for World Economics, Sepember Woodford, Michael (1999). Pifalls of Forward-Looking Moneary Policy. Mimeo, Sanford Universiy. 26

27 Appendix 1 Table 1: Dependen Variable is Refinancing Rae, Monhly Daa 1993: :12 Independen variable Tradiional Taylor rule (wih yearly inflaion) Inercep (4.64) *** Year-o-year 0.31 consumer price (0.03) *** inflaion Monhly consumer price inflaion Oupu gap Growh in real effecive exchange rae Growh in real effecive exchange rae (-1) (1.07) Tradiional Taylor rule (wih monhly inflaion) (6.10) *** 4.95 (0.68) *** (133.60) *** Open economy rule (wih yearly inflaion) 3.00 (2.61) 0.04 (0.02) * 0.32 (0.57) (35.33) (31.73) Open economy rule (wih monhly inflaion) 1.60 (2.55) 1.31 (0.48) *** 0.05 (0.50) (42.37) (31.08) Ineres rae (-1) 0.90 (0.04)*** 0.90 (0.03) *** R squared Adjused R squared Durbin Wason saisics Breusch-Godfrey es* *** *** No rejecion No rejecion Noes: -The Breusch-Godfrey serial correlaion LM-es (wih no auocorrelaion as a null hypohesis) was conduced for welve lags. (-1) indicaes a firs lag. -Sandard errors are in parenheses. The aserisks indicae levels of significance a 10 (*), 5(**) or 1 (***) percen level. 27

28 Table 2: Dependen Variable is Growh Rae of M1, Monhly Daa 1993: :12 Independen variable Difference model Gap model* Full Model Inercep (0.0044) *** (0.0047) ** (0.0045) *** Quarer-o-quarerinflaion (0.0006) *** (0.0007) *** Quarer-o-quarerinflaion (-1) (0.0006) *** (0.0006) * Monhly inflaion (0.0015) Dummy (for period before 1995) * monhly (0.0020) ** inflaion Monhly inflaion (-1) (0.0007) * (0.0009) Oupu gap (0.0011) (0.0009) Growh in real effecive exchange rae (0.0719) *** Growh in real effecive exchange rae (-1) (0.0664) *** Growh in bilaeral dollar exchange rae (0.0536) *** (0.0846) *** Dummy for period before 1995 growh in (0.1262) ** bilaeral dollar exchange rae /1 Growh in bilaeral dollar exchange rae (-1) (0.0541) *** (0.0480) ** Growh rae of M1(-1) (0.0685) *** (0.0697) ** (0.0666) *** Seasonal dummy for January (0.0129) *** (0.0137) *** (0.0130) *** Seasonal dummy for December (0.0106) *** (0.0112) *** (0.0107) *** Slope dummy for Augus 1998 (0.0331) ** Dummy for he period before May 1998 (0.0065) ** Dummy for period before 1995 (0.0231) * R squared Adjused R squared Durbin Wason saisics Breusch-Godfrey es No rejecion No rejecion No rejecion Noe: /1 In his case we deduc he HP-rend from quarer-o-quarer inflaion and he growh in he dollar exchange rae. Sandard errors are in parenheses. The aserisks indicae levels of significance a 10 (*), 5(**) or 1 (***) percen level. 28

29 Table 3: Dependen Variable is a Weighed Average of Ineres Rae and Real Effecive Exchange Rae, Monhly Daa 1993: :12 Independen variable Exchange rae weigh=1 Exchange rae weigh=0.5 Inercep (3.0818) * ( ) Oupu gap (0.1569) (1.1052) Oupu gap (-1) (0.1620) ** (1.3301) Oupu gap (-2) (0.1630) ** (1.1005) Monhly ineres rae * (real effecive exchange rae (-1)) (0.2588) *** (0.4665) * Monhly ineres rae (-1) * (real effecive exchange rae (-2)) (0.2624) (0.4603) R squared Adjused R squared Durbin Wason es saisics Breusch-Godfrey es No rejecion possible *** Noes: - The Breusch-Godfrey serial correlaion LM-es (wih no auocorrelaion as a null hypohesis) was conduced for welve lags. - (-1) indicaes a firs lag. - Sandard errors are in parenheses. The aserisks indicae levels of significance a 10 (*), 5(**) or 1 (***) percen level. 29